The Bank Lending Channel and Monetary Policy Rules: Further Extensions

Many channels exist through which monetary policy decisions affect the economy. This paper examines the bank lending channel, which reflects the central bank's actions that affect loan supply and real spending. The main variable that affects loan supply is the monetary policy indicator as it is proxied by the real short-term interest rate. This paper examines how the bank lending channel operates when this short-term indicator is endogenously determined by the target rate the central bank sets through a monetary policy rule. Furthermore, it examines whether different bank-specific characteristics affect the way banks react to a monetary shock. We investigate the effect of such a rule on the bank lending channel in European banking institutions spanning 2000 through 2009. The expectations, concerning both inflation and output, affect the decision of the central bank for the target rate, which, in turn, affect the private sector's expectations -banks- by altering their loan supply.